Annual Income

What is Annual Income?

Annual income is the total amount of money you earn during a year. It represents the total amount you have earned over 12 months, usually from employment, business, investments, or other sources.

For example, you start working, and every month, you earn $5,000.00. So, over 12 months, your annual income will be $60,000.

Income is not limited to just salary, which can vary depending on the sources of the monetary funds you receive. This includes passive income from rental, interest, and dividends, or profits from a business or business deal that may come as bonuses and commissions.

It is a key indicator of your financial stability. Thus, providing a comprehensive picture of your financial status.

It is one of the things that credit companies look for if they want to issue you credit. A higher income can give you a lower rate and a higher credit limit, though other factors can impact this.

purpose of an annual income

In many countries, yearly income determines a person's or organization's tax obligations. It also determines their eligibility for government programs and benefits, such as unemployment benefits or food assistance.

If you earn dividends in a taxable account, that is also part of your annual income.

For example, your yearly base salary is $100,000, and you are paid $20,000 yearly in dividends. That means that you have earned $120,000 in total.

Capital gains sales will drive up your annual income. This is called adjusted gross income (AGI), which considers all your sources of income.

But do not be frightened! The IRS taxes long-term capital gains differently than ordinary and short-term income. Therefore, long-term capital gains will not position you in a higher tax bracket.

That is because long-term capital gains receive a lower tax rate and are taxed separately from ordinary income. As a result, ordinary income and short-term capital gains are taxed first.

Tax Rates

The 2023 tax rates are the following:

Source: Forbes

The 2023 long-term capital gains tax rates are the following:

Source: CNBC

Long-term capital gains tax works in the following way:

• It is based on your income
• It is based on how your taxes are filed, i.e., single, jointly, etc.

For example, you are a single filer. Your income is $30,000, and you have recently sold a long-term asset for $100,000.

Your adjusted gross income would be $130,000. Your salary income falls into the 0% long-term capital rate category. That means that for 2023, you would pay no taxes for $14,625 ($44,625-$30,000). 

Remember that your adjusted income is $130,000, meaning the remaining $100,000 is $85,375 ($100,000-$14,625). That amount is taxed at 15%, amounting to $12,806.25. 

Your base salary is taxed separately, which means that for 2023 your base salary is 12%. That's a relief because your AGI for 2023 fell under the 24% bracket.

In total, you have paid in taxes $16,406.25:

• Salary: For your $30,000, you paid in taxes of $3,600 (12% rate).
• Long-term capital gains: For your long-term gains of $100,000, you paid $12,806.25. 

That means that your long-term capital gains were taxed at 12.8%.

If instead, your capital gains were short-term, your AGI would be $130,000. You would be taxed at 24%, a whopping $31,200. It pays to hold long-term for tax purposes!

Gross Annual Income Vs. Net Annual Income

Yearly income can be categorized in two: 

1.  Gross income 
2.  Net income

Let’s take a look:

Gross annual income

Gross income is the amount you earn each year before deductions and taxes. This includes salary, dividends, passive income, and other sources. Your gross income is a starting point for preparing and filing your yearly income tax return.

For instance, if you earn $5,000 per month, your gross monthly income is $5.000 per month. Understanding your gross income can help you calculate your net income. Your annual gross income is also used to assess your loan or credit card eligibility. 

In a business, gross income is listed in the tax returns for your business. It is calculated by subtracting sales from the cost of goods sold (COGS).

For example, a business generates $1,000,000 in sales, but the cost of selling its product is $300,000.

So we have the dollar amount in sales and cost of goods sold, we subtract both, and we get that the gross income for the business is $700,000.

Net annual income

Your net income is your total yearly income after all deductions and taxes are considered. For example, if we use the above example and assume that $500 is deducted from your monthly income for taxes, your net monthly income would be $4,500.

Knowing what you take home after taxes is crucial when budgeting because a certain percentage of your gross income is deducted for taxes.

Fundamentally, it is also important to know your net income because that is the amount of money you take home or your business generates.

If your business’s gross income is low, that means your business is not generating strong sales relative to your costs. This impacts further down the line if the business has to incur additional payments. Business can be compared through certain metrics, and gross margin is one of them.

The formula is Sales - COGS / Sales: A higher margin means the business can pay other indirect costs and expenses.

Income Categories

There are many ways a person or business can earn money. This can include earnings from salary or the gross profit from a business. This forms part of your gross income that we previously talked about.

To recap, long-term capital gains also form part of your gross income. Net income is how much you take home after deductions and taxes have been taken out. You are taxed differently depending on whether your annual income is short-term capital gains, long-term capital gains, or a combination of both.

1. Earned income 

All taxable salaries, income gained from employment, and disability payments are included in earned income. Commissions, overtime pay, tips, and bonuses are all earned money. 

Self-employment is also considered a source of income. Interest and dividends, pensions, social security, unemployment payments, alimony, and child support are all examples of non-earned income.

2. Employment income

Employment income covers salary, wages, allowances, overtime pay, pension, annuity, directors' fees, bonuses, management fees, gratuities, retirement allowances, and extra salary.

3. Self-employment and business income

This category includes all self-employment and business-owner revenue.

4. Social security and pensions

Social security only covers earned income, such as your wages or self-employment earnings. This means you're contributing to the Social Security system, which covers you for retirement, disability, survivors' benefits, and Medicare.

5. Passive Income 

This type of revenue is generated by money gained without the need to work hard. 

Rent from an apartment you own, income from a business where the owner isn't actively involved in any work that generates passive income.

6. Court-ordered alimony and child support 

Spousal support and child support payments are included in your overall income for the year. A court must grant child maintenance for three years to be included in your yearly income calculation.

7. Gained interest and investment income 

Profits from the sale of stocks, real estate, or other income-producing investments are included in your yearly income. In addition, any interest earned on savings accounts is also included in your income.

How to Calculate Annual Income

While certain aspects of your income will be straightforward to compute with basic addition, others necessitate additional computations.

If you want to calculate your yearly income over the year, you can figure out how much money you make each year by doing the following:

• Make a list of all sources of income. Ex: Salary, passive income, etc
• Compute all yearly earnings. 
• Compute all monthly earnings.
• Compute all hourly wage earnings.
• Compute all hourly earnings.
• Determine your annual earnings. 

1. Make a list of all sources of income

Make a list of all the different types of revenue you receive from the list above. Make careful to indicate the amount of money you earn from each source. 

Any revenue for which you have an entire year of records may be added together. For example, you can add $500 from judgment fees and $50,000 from capital gains after selling an investment property. Your annual salary is $50,500 at this point.

2. Monthly Earnings Calculation

Any new monthly revenue will necessitate a simple calculation. Multiply your monthly income by 12 because a year has 12 months.

Your monthly earnings would be $2,500 if your rental income was $2,000 and your self-employment income was $500. Divide your $2,500 monthly earnings by 12 months to get the total. This equates to a yearly salary of $30,000 for you.

3. Compute all hourly wage earnings

Write down the payment amount on your most recent payslip and the number of hours you worked that week. 

Consider the following scenario: Your pay slip from a new courier job indicates $907.50 for 33 hours of labor each week, plus additional bonus payments. The hourly wage is $27.50, while $907.50 is divided by $ 33.

4. Compute all hourly earnings

The method for calculating hourly income described above can assist you in calculating employment income.

To calculate your weekly wage, multiply the hourly wage by the average number of hours worked per week. Permanent employees double this compensation by 52, the year's number of weeks.

5. Calculation

To calculate your annual income, add your yearly, monthly, and hourly income calculations together. To get a total gross annual income, add your yearly income amount to your monthly income calculations and your hourly income calculations.

Researched and authored by “Won S. Mejia Helfer” | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accrual Accounting
• Contribution Margin
• Earnings Before Tax
• Net Income After Tax (NIAT)
• Progressive Tax